Section 1031

DEFINITION of Section 1031

Section 1031 is an Internal Revenue Code (IRC) provision that defers tax on qualifying exchanges of like-kind real estate. Section 1031 is also known as the Starker Loophole. Qualifying Section 1031 exchanges are called 1031 exchanges, like-kind exchanges, or Starker exchanges.

BREAKING DOWN Section 1031

Section 1031 defers tax on properly structured 1031 exchanges. For 1031 exchanges concluded prior to December 31, 2017, like-kind property includes a broad range of real and tangible personal property held for business or investment such as franchises, art, equipment, stock in trade, securities, partnership interests, certificates of trust, and beneficial interests. For 1031 exchanges concluded after December 31, 2017, recently enacted tax legislation makes it clear that the only permissible property is a business or investment real estate. As a result of this change, this article focuses on 1031 exchanges of like-kind business and investment real estate concluded after December 31, 2017.

Section 1031 Real Estate

Section 1031 property, for 1031 exchanges concluded after December 31, 2017, is real estate held for investment or for productive use in a trade or business. The real estate must be located in the United Sates to be like-kind.

Section 1031 Steps to a Tax-Deferred Exchange

Section 1031 defers tax on swaps of like-kind real estate done in a timely manner. The most important steps to a properly structured 1031 exchange are: (1) Replacement real estate must be like-kind. (2) Tax must be paid on any “boot” in the year of the 1031 Exchange. (3) Once business or investment real estate is sold, replacement like-kind real estate must be identified within 45 days and acquired within 180 days. Each of these steps are discussed in greater detail below.

Step 1: Like-Kind Real Estate Defined

Section 1031 defines like-kind as real estate that is held for productive use in a trade or business or for investment. Section 1031 defers tax when this real estate is exchanged in a properly structured 1031 exchange for like-kind real estate that continues to be held for productive use in a trade or business or for investment.

Step 2: Boot Defined

Section 1031 allows an investor to give or receive cash, liabilities or other property that is not like-kind in addition to the like-kind real estate exchanged. Cash, liabilities or other property that is not like-kind and that is given or received in a 1031 exchange is called “boot.” Boot triggers taxable gains or losses in the year of the exchange. The taxable amount that is not deferred by Section 1031 is the amount of the boot. The taxable amount that is deferred by Section 1031 is the capital gain or loss on the like-kind real estate exchanged.

Step 3: Exchange Timing

Section 1031 gives a taxpayer who sells business or investment real estate 45 calendar days from the closing to identify up to three (and under certain circumstances four or more) like-kind replacement real estate properties. The replacement must be acquired and the 1031 exchange completed by the earlier of 180 calendar days or the due date (with extensions) of the taxpayer’s return.

A like-kind exchange is a tax-deferred transaction that allows for the disposal of an asset and the acquisition of another similar asset without generating a tax liability from the sale of the first asset.

Form 1099-B: Proceeds From Broker and Barter Exchange Transactions is a tax form issued by brokers or barter exchanges that list the gains or losses of all broker or barter exchange transactions. Brokers and barter exchanges must mail 1099-B forms by January 31.